Month: June 2016

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Quick update on the financial impact of Brexit after one day of trading. Bad in the US, but terrible overseas, especially in financials. Vanguard’s Total World Market ETF was down 5.35%. I like to use that as a proxy for all the assets in the world, which are worth 5% less today than they were yesterday at this time (or, more optimistically, they’re 5% cheaper than they were yesterday). Again, no one knows if this is an over-reaction, if there will be a bounce in the short-term, or if this is the beginning of a big move down. Most importantly, no one knows what the long-term economic impact will be. The unwinding of positions just needs to play out in the market for a while in the short term and a LOT of negotiations, votes, and policy decisions need to be made in Europe over the long-term (likely several years). Here’s where things settled today, with all returns below by representative ETF, in US Dollars (captures market impact and currency impact together):

As I type this message, the votes are being counted in the UK referendum on whether to remain in the Euro zone or exit (British Exit, “Brexit”). With approximately 2/3rds of the voting areas reporting, the result looks like a narrow victory for the exit camp. This comes as a total shock to the financial markets, which had been pricing in a win for the Remain side, based on recent poll data, and similar votes in other countries in recent years. Virtually all economists are in agreement that this will have a detrimental impact on UK GDP, at least in the short-term, and maybe in the long-term. It also signals a possible unraveling to the Euro zone if other countries reach similar decisions. The future impact is all based on speculation at this point. Is it better for the UK to extract itself from a potentially failed experiment in trying to combine countries in Europe that are too culturally different to be combined, even if there is some short-term economic pain? Might it even be better for the world if the countries of the Euro zone all return to their previous status as completely separate entities that are not as dependent on each other? Or does the obliteration of trade agreements, a common currency, and a determination to become more unified wind up hurting global growth irreparably? No one knows these answers.

What we do know is that when financial markets are shocked by an unexpected event that MAY have major economic implications for the future (MAY emphasized, because whether it does have those implications or not is irrelevant), volatility ensues. In this case, it is led by the currency markets as the value of a British Pound can change dramatically if the market in aggregate believes now that investments in the British economy will offer poorer returns in the coming years than they did yesterday. Major swings in one currency often trigger major swings in other currencies in a rush to safety (US Dollar) and away from riskier and higher yielding currencies. Currency swings impact the economies of the countries that use those currencies. Currencies that depreciate in value gain an export advantage over other countries, but the cost of imported goods can rise sharply and hurt more than the exports can stimulate growth. Stock market fluctuations follow from the economic impacts and volatility there can be self-fulfilling as leveraged losing bets cause additional forced selling via margin calls and fund liquidations. In financial markets, fear begets fear. As you might expect, the British pound is incurring substantial declines in overnight markets… currently down almost 10% vs the US dollar, back to levels not seen since 1985. World equity markets are also suffering, with US markets down 3-4%, the UK down 7.5%, and Asian markets down as well. US bonds are a bright spot, as is almost always the case in situations like this, which is the reason we include bonds in your portfolios even when interest rates are low. They are a source of stability and are negatively correlated with other assets.

While it’s always possible that there will be a quick snap back rally, events such as this tend to take a while to play out in the markets as bottom-pickers try to time their bets (exerting buying pressure and causing a rebound in prices), while funds with liquidation requests and leveraged bets that led to margin calls force additional selling (downward pressure) on the markets. As is usually the case, the market knows best what a fair price is given the current situation, so we don’t see this as a reason to panic and sell, or a particular “buying opportunity” beyond the investing of spare cash that you should always be doing and that’s part of your financial plan. It’s merely something that has now happened and is priced into the markets. Over the long-term, the economic impacts will play out, and prices will continue to adjust as those impacts are better understood.

The long and short of Brexit is this: tomorrow is likely to be a very ugly day in most financial markets. The gains of the last few months are likely to be wiped out (and then some). Will that change the fact that over the long-term, populations will continue to grow, people will continue to work, and productivity will continue to increase through process and technological advances? Call me skeptical, but I doubt it. The world’s economic output, in all likelihood, will continue to grow over time and we’ll look back on this as yet another event in the history of financial markets that caused a lot of headlines to be written and a lot of fear to swell over a temporary blip in overall growth. We have no idea whether the UK will benefit or be hurt by their democratic decision (if they even go through it). But the world as a whole will be just fine after some time to adjust to the new landscape. In other words, I sincerely doubt any of you will be telling your grandchildren that their lives would be so much different if only 2% more of the UK voted to stay in the EU on 6/23/16.

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The PWA (Perpetual Wealth Advisors) Financial Tastings Blog is intended to provide our clients and other interested readers with bite-sized, easily digestible information on personal finance topics. We used to publish a quarterly newsletter with similar information and will be archiving some of those topics here. Instead of continuing with a publication that was akin to a seven-course meal every three months, we have found that the fast-paced, mobile-driven world required smaller amounts of information, communicated more frequently. We've turned to the blogging concept to provide it. Topics will include both original content and links to other articles of interest. They will span key areas of personal finance including planning, goal setting, budgeting, cash flow management, debt management, risk management, employee benefits, tax, investments, retirement planning, and estate planning. We'll try to keep posts brief, simplify where possible, and answer as many questions as we can. Speaking of questions, feel free to send them to blog@perpetualwealthadvisors.com. We'll occasionally open up the mailbag for a Q&A post. Bon appetit!

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